In the financial field of insurance, individuals are provided with an opportunity to fund their retirement income through the purchase of annuity contracts. An annuity contract generally involves an insured individual paying money to an insurance company and the insurance company pooling the insured's money with moneys paid by other contract purchasers having reasonably similar retirement funding desires, and investment and survivorship risks. The contract is used to invest the contract holders funds and pay back accumulated moneys primarily as retirement income, usually calibrated as income guaranteed over the lifetime of the annuitant. The annuity contract thus protects an insured individual from the adverse financial consequences associated with living too long.
To provide an insured with such lifetime guaranteed protection generated through the mechanism of an annuity contract, the insurance company studies the statistics associated with investing and people's mortality, adjusting these statistics to recognize the particularities of the contract.
Such contracts are variously called lifetime income, life payout, or immediate life annuities when the contract immediately (within 13 months) begins paying income contingent on the individual living, and deferred annuities when the contract does not begin to pay income out immediately.
Before retirement the financial risk of living is generally funded by an individual on a pay-as-you-go basis from employment earnings. Upon retirement, other sources are needed to provide such moneys. Social Security and private pensions provide some such moneys, and various individuals might receive income moneys from other sources. But for many people, some of whom have no such sources, their own personal assets must be relied upon as the sole or is supplementary source of such moneys.
This often presents a dilemma because of the risk of living too long. The dilemma is that people do not know how long they are going to live. So in the first place, they often do not accumulate sufficient assets. Then, if they dip into principal in addition to earnings on their assets, they could run out of money if they live too long. To be safe, they could take only earnings as income, but such earnings are often not enough, forcing the person to skimp. Moreover, earnings on most investments vary; low earning years may also require a withdrawal from principal. The risk of living too long has been and promises to continue to be a rising concern as more people reach retirement and retired people live longer.
Moreover, faced with this dilemma, inflation can pose an added burden for ever-increasing income, compounding the financial risk of living too long. There are also extra risks and financial strain on retired individuals concerning uninsured health care costs.
Life annuities generally pay specified income amounts to a contract holder at the end of routine intervals, such as monthly or yearly, to which the insured annuitant survives, and in most instances provide this contractual protection for all future intervals the individual lives. In such instances, the amounts of income includes the payout of principal, as well as investment earnings, calibrated over the statistically expected lifetimes of all of the annuitants. As such, life annuities solve the dilemma of the risk of outliving one's savings by safely tapping into principal so as to provide more significant income. Only insurance companies (and certain self-insuring groups) provide such lifetime guarantees connected with tapping into principal.
In establishing the payout amounts in this way, in the purest form of these annuities, pure life only annuities, principal and/or interest are not available after income payments commence, neither for withdrawal nor on or after the annuitant's death. To do otherwise on death negates the calibrated redistribution of these amounts back to surviving annuitants; and to do otherwise on withdrawal has the same effect because moneys could be withdrawn as annuitants neared death.
Since principal is not available on death, even if death occurs before income payments commence under this pure life annuity, insurance companies generally provide miscellaneous options for pay-backs on death. Such death benefit options are generally paid for by a reduction in income level or a corresponding increase in purchase payment. Some of the more common death benefits are: to continue income payments to the beneficiary for the remainder of the first 10 or 20 years from issue; to continue payments until the purchase payment has been paid through income payments, first to the annuitant while alive and then to the beneficiary (called installment refund); or to pay the remainder of the purchase payments in cash at the time of death (called cash refund).
Death benefits options have also been used as the backdrop for giving contract owners liquid access to values in the contract. Thus, to the extent a death benefit option is in effect, contract holders have in certain contracts been given the right to withdraw moneys connected to the death benefit available, subject in some more recent products to charges to recover unamortized acquisition costs and/or adjustments for disintermediation.
Certain contracts have recently also provided for various options to periodically increase the amount of the income payable to offset the effects of inflation. Other contracts, called variable annuities, tie the income amounts to the performance of the investment in separate accounts that are similar to mutual funds. And some others have begun to offer benefits and rate classifications connected to the health of the annuitant.
Although there are many different types of annuity contracts, little has been done to demonstrate and explain the underlying mechanism of life annuities to the public or insurance sales and service people. There has also been a lack of financial disclosure in connection with how life annuity contracts work. A major facet of this shortcoming involves the non-disclosure of certain periodic, mainly yearly, financial components funding values inherent in how these contracts operate both in general and in the individual case. Most particularly, the workings and values of the living factor has not been disclosed.
As such, prospective purchasers and contract holders, and even distributors, quite often do not understand or have limited understanding of what they are buying or selling. They are not aware of the options that might be available, nor are they fully cognizant of the financial implications of their decisions. Decisions are often uneasy, uninformed, and in many instances not what would have been chosen had more been known.
Moreover, component funding values such as living contingent values have not been enhanced, nor have they been integrated into other annuity contract frameworks. The insurer is also less subject to accountability on its ongoing declarations.
Then too, access to values and the value of living have been limited because of underwriting concerns.
There is a need for a system that provides more disclosure of the workings of life annuity contracts so that when the contract is presented to customers they can appreciate and act on all of such contracts' critical components. Likewise, there is a need for a system that will enable such critical components to be enhanced.